Is This The Top For Oil Prices For Now?

E&P earnings are coming in and the impression we’re left with is that natural gas investment in Marcellus is being reduced, while oil overall appears to be incrementally ramping up versus prior guidance. Also, production overall for 1Q15 has exceeded sell side expectations as well, as reported by many public companies.

Noble (NBL) reported that it’s cutting investment in the Marcellus by some $200M in response to the Nat Gas price crash. This is on top of prior production reductions at Chesapeake (CHK) & Range Resources (RRC). However, the Ponzi game in shale oil, having to continuously drill to replace 80% 12 month decline rates in existing production and having to burn yet more cash in doing so, is continuing to push production higher. Related: How Shale Is Becoming The .COM Bubble Of The 21st Century

Devon Energy (DVN) raised production some 5% while Pioneer Resources (PXD) hinted that, if prices recover, they may add 2 rigs starting in July 2015 and, in their words, production in 2016 could return to double digits. If you are expecting oil to cover above $70, we caution you on such expectations at least in the shorter term.

Firstly, although the weaker dollar is a reflection of a much weaker underlying economy than reported in headline economic and talking head media, it will still help some. However, weaker economic growth in the US as well as, in all likelihood, the failure of QE in Europe as well as China, will ultimately weigh on demand. Related: The Greenest Oil Companies In The World

Secondly, the private equity monies sloshing around (some $50B) will also allow these broken shale models to continue versus allowing the market to efficiently bankrupt the weaker producers while rewarding the strong ones while overall reducing output. The bailouts post-2008 by the government in the auto industry and banking seem to be a systemic result of the Federal Reserve insisting that ultra-easy money is the way out of the 2008 crash, while history says otherwise. In addition, lease operating expenses appear poised to fall 10% which, on top of reduced capital expenditure costs, will also reduce financial pressure on weaker players even more.

The recent EIA & API fall in oil stockpiles is encouraging (EIA reported a 3.9MB weekly drop) as well as data indicating that production is flattening, as reported by EIA. But unless the market players show better discipline, and investors better judgment in not allocating monies to broken models, prices will remain depressed. It should be noted too private equity is inflating asset prices given the need to invest the billions of dollars raised recently. We have heard bids as high as 30% above E&P bids if one can believe this. This too will act as a lifeline to weaker players selling assets to extend their existence pressuring supply. Related: Audi’s Fuel Breakthrough Could Revolutionize The Automotive Sector

Overall we are not expecting WTI prices to revisit the $40s again but a temporary top appears likely until the industry works down overall inventory. E&P companies are clearly reflecting this as the hedging for later in 2015 & 2016, thus flattening the price curve, has picked up considerably recently. In our view, the companies building liquidity into the 2H15 will be in the best position to grow, as eventually the weaker players will fall and so will the inflated prices they seek for assets.